Pig run

Food prices rose 5.9% in April, pushing China’s consumer price index (CPI) up 2.8%, its fastest rise in 18 months. But Mrs Zhang, a butcher at Beijing’s Sanyuanli market, isn’t panicking – so long as prices don’t go up so much that customers start complaining.

The chalked prices on the blackboard behind her cleaver-wielding husband have changed little so far this year. "Our pork costs around RMB16 (US$2.34) per kilo, and that hasn’t changed much over the past few months," said Zhang. "People who buy our pork – mostly local restaurants – have been talking about food prices going up, but nobody really thinks it’ll be that bad. Nobody around here is too worried about inflation."

But on the other side of town, some officials are beginning to show concern.

Index heavy

Pork accounts for 9% of the 32% that food contributes to the CPI basket, and as such it is often used as a weather vane for inflationary pressures. That weather vane appears to be pointing in the direction of higher consumer prices.

"Since both corn prices and rural labor costs have been rising at a pace of around 10% per year, we expect pork prices to rise at a similar pace on a supposed equilibrium path," said Lu Ting, China economist at Bank of America Merrill Lynch. Commercial pork producers Yurun (1068.HK) and Zhongpin (HOGS.NASDAQ) have made similar predictions for this year.

Yao Jingyuan, chief economist at the National Bureau of Statistics (NBS), believes that inflation will continue its upward trajectory due to pressure from food prices, while remaining below the government’s target of 3% for the year. "We should be alert to price increases in some particular products that will affect the overall inflationary trend, like surging pork prices did in 2006," cautioned Yao. Between 2006 and 2007, retail pork prices soared by 50%.

Zhang’s prices haven’t changed much, but average nationwide prices have – and they are falling, not rising. By April, pork prices had fallen for 14 consecutive weeks to an average of RMB9.43 (US$1.38) per kilo, hitting a four-year low.

The drop in prices largely stems from the aftereffects of the 2007 outbreak of porcine reproductive and respiratory syndrome, also known as blue ear disease. Supply fell in the cull following the outbreak and, together with a jump in feed prices due to unusually harsh weather conditions, pork prices skyrocketed.

In response, Beijing offered farmers subsidies for raising sows to replenish the swine stock and pull back prices. It released US$366 million to support investment in pig farm construction, US$95.2 million to subsidize high-quality breeding, and another US$307 million in general subsidies to pork-producing regions.

Pig supply soon outpaced demand. This imbalance – plus fears of an outbreak of hand, foot and mouth disease toward the end of last year – saw farmers slaughter more pigs to put them on the market, leading to a glut of pork supply that further dragged down prices.

"Added to this, demand in the period after Spring Festival traditionally dips and is seasonally lower during the warm summer months," said Feng Younghui, chief analyst at Zhongke Yiheng Modern Agriculture & Animal Product Technology Research Institute.

As the price spikes of 2007 show, cyclical trends in the pork supply chain are not new to China. This adds credence to concerns that the current low prices will cause a drop-off in production, reversing the demand and supply situation but still leaving it imbalanced. The government’s interventionist policies, though well intended, may amplify the problem.

Introduced in January 2009, the National Swine Price Alert System allows the government to buy pork from the market and place it in a strategic frozen reserve when the live hog-to-grain-price ratio falls below 6.0 for a period of four weeks. Two such purchases were made in April to curb supply and bump up prices.

Short-term solutions

Some industry experts question the long-term feasibility of stockpiling as a means of controlling pork price fluctuations.

"The government has so far not been able to find a way to allow for balanced adjustments in the market, and stockpiling is only a short-term solution," said Guo Huiyong, head analyst at Beijing Orient Agribusiness Consultant (BOABC).

Echoing this view, Zhongke Yiheng’s Feng argues that, while government intervention can stabilize downstream prices to benefit consumers, it does little to enhance the structure of the industry as a whole. This is because the policies are remedial rather than preventative.

"Policies like stockpiling are only executed after a movement in prices has occurred in the market," said Feng. The lag between what happens upstream, the change in market price and the government response exacerbates the imbalance in supply and demand, according to Feng. The result is more frequent price fluctuations. He advocates allowing the whole industry to operate under market conditions. "Only in this way will we see the industry develop in a healthy way."

Rising livestock feed prices and Beijing’s stockpiling mean pork prices are indeed likely to rise. But barring unforeseen circumstances, such as a nationwide disease outbreak, the extreme spikes seen in previous years are unlikely to be repeated.

Even if pig prices do rise, a solution may be found in the statistics themselves. The NBS has already indicated a willingness to change the disproportionate weighting of pork prices in CPI calculations. Wei Guixiang, the director of the NBS’s social economic surveying department, has said housing-related costs such as home prices, which are not officially included in the CPI basket, and mortgage loan rates would be allowed to carry more weight in the index.

The bureau increased the weight of the residence category of CPI computation from 14% last year to 15% this year and has suggested that food’s weighting will be reduced in 2011. "People’s outlay on residence has been increasing rapidly and food consumption is a shrinking part for a family," Wei said earlier this year.

Disproportionate or not, for the time being food prices continue to occupy one-third of the inflation basket, and higher prices could still put pressure on the CPI. But not everyone is concerned. "Even if prices do go up by 10% in the second half, that means a kilo of pork will only cost about RMB15 (US$2.20)," said Guo of BOABC. "That’s still pretty cheap."

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